IRS Releases Publication 4222 (10/2015), 401(k) Plans for Small Businesses

WHY 401(k) PLANS?

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This publication constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996. Its publication does not constitute legal, accounting, or other professional advice.

WHY 401(k) PLANS?

401(k) plans can be a powerful tool in promoting financial security in retirement. They are a valuable option for businesses considering a retirement plan, providing benefits to employees and their employers.

Employers start a 401(k) plan for many reasons:

ESTABLISHING A 401(k) PLAN

When you establish a 401(k) plan, you must take certain basic actions. One of your first decisions will be whether to set up the plan yourself or to consult a professional or financial institution -- such as a bank, mutual fund provider, or insurance company -- to help with establishing and maintaining the plan. In addition, there are four initial steps for setting up a 401(k) plan:

Once you have decided on a 401(k) plan, you will need to choose the type of 401(k) plan that is best for you -- a traditional 401(k) plan, a safe harbor 401(k) plan, or an automatic enrollment 401(k) plan. In all of these plans, participants can make contributions through salary deductions.

A traditional 401(k) plan offers the maximum flexibility among the three types of plans. Employers have discretion over whether to make contributions for all participants, to match employees' deferrals, to do both, or to do neither. These contributions can be subject to a vesting schedule (which provides that an employee's right to employer contributions becomes nonforfeitable only after a period of time). Annual testing ensures that benefits for rank-and-file employees are proportional to benefits for owners/managers.

There are several kinds of 401(k) plans that aren't subject to the annual contributions testing required with traditional 401(k) plans. These are known as safe harbor 401(k) plans and, in exchange for avoiding the annual testing, employees in these plans must receive a certain level of employer contributions. Under the most popular safe harbor 401(k) plan (discussed in this publication), mandatory employer contributions must be fully vested when made.

An automatic enrollment 401(k) plan allows you to automatically enroll employees and place deductions from their salaries in certain default investments, unless the employee elects otherwise. This is an effective way for many employers to increase participation in their 401(k) plans.

The traditional, safe harbor, and automatic enrollment plans are for employers of any size.

This booklet addresses traditional and safe harbor 401(k) plans. For more information on automatic enrollment 401(k) plans, see Automatic Enrollment 401(k) Plans for Small Businesses (Publication 4674).

Once you have decided on the type of plan for your company, you will have flexibility in choosing some of the plan's features -- such as which employees can contribute to the plan and how much. Other features written into the plan are required by law. For instance, the plan document must describe how certain key functions are carried out, such as how contributions are deposited in the plan.

Arrange a trust for the plan's assets -- A plan's assets must be held in trust to assure that assets are used solely to benefit the participants and their beneficiaries. The trust must have at least one trustee to handle contributions, plan investments, and distributions. Since the financial integrity of the plan depends on the trustee, selecting a trustee is one of the most important decisions you will make in establishing a 401(k) plan. If you set up your plan through insurance contracts, the contracts do not need to be held in trust.

Develop a recordkeeping system -- An accurate recordkeeping system will track and properly attribute contributions, earnings and losses, plan investments, expenses, and benefit distributions. If a contract administrator or financial institution assists in managing the plan, that entity typically will help keep the required records. In addition, a recordkeeping system will help you, your plan administrator, or financial provider prepare the plan's annual return/report that must be filed with the Federal Government.

Provide plan information to employees eligible to participate -- You must notify employees who are eligible to participate in the plan about certain benefits, rights, and features. In addition, a summary plan description (SPD) must be provided to all participants. The SPD is the primary vehicle to inform participants and beneficiaries about the plan and how it operates. The SPD typically is created with the plan document. (For more information on the required contents of the SPD, see Disclosing Plan Information to Participants.)

You also may want to provide your employees with information that discusses the advantages of your 401(k) plan. The benefits to employees -- such as pretax contributions to a 401(k) plan (or tax-free distributions in the case of Roth contributions), employer contributions (if you choose to make them), and compounded tax-deferred earnings -- help highlight the advantages of participating in the plan.

OPERATING A 401(k) PLAN

Once you have established a 401(k) plan, you assume certain responsibilities in operating it. If you hired someone to help in setting up your plan, that arrangement also may have included help in operating the plan. If not, another important decision will be whether to manage the plan yourself or to hire a professional or financial institution -- such as a bank, mutual fund provider, or insurance company -- to take care of some or most aspects of operating the plan.

Elements of operating 401(k) plans include:

Typically, a plan includes a mix of rank-and-file employees and owners/managers. However, a 401(k) plan may exclude some employees if they:

Contributions

In all 401(k) plans, participants can make contributions through salary deductions. You can decide on your business's contribution to participants' accounts in the plan.

Traditional 401(k) Plan

If you decide to contribute to your 401(k) plan, you have further options. You can contribute a percentage of each employee's compensation for allocation to the employee's account (called a nonelective contribution), or you can match the amount your employees decide to contribute, or you can do both (within the limits of the tax law).

For example, you may decide to add a percentage -- say, 50 percent -- to an employee's contribution, which results in a 50-cent increase for every dollar the employee sets aside. Using a matching contribution formula will provide employer contributions only to employees who make deferrals to the 401(k) plan. If you choose to make nonelective contributions, the employer contribution goes to each eligible participant, whether or not the participant decides to make a salary deferral to his or her 401(k) plan account.

Under a traditional 401(k) plan, you have the flexibility of changing the amount of employer contributions each year, according to business conditions.

Safe Harbor 401(k) Plan

Under a safe harbor plan, you can match each eligible employee's contribution, dollar for dollar, up to 3 percent of the employee's compensation, and 50 cents on the dollar for the employee's contribution that exceeds 3 percent, but not 5 percent, of the employee's compensation. Alternatively, you can make a nonelective contribution equal to 3 percent of compensation to each eligible employee's account. Each year you must make either the matching contributions or the nonelective contributions. The plan document will specify which contributions will be made and this information must be provided to employees before the beginning of each year.

Roth Contributions

401(k) plans may permit employees to make after-tax contributions through salary deduction. These designated Roth contributions, as well as gains and losses, are accounted for separately from pretax contributions. However, designated Roth contributions are treated the same as pretax contributions for most aspects of plan operations, such as contribution limits.

A 401(k) plan may allow participants to transfer certain amounts in the plan to their designated Roth account in the plan.

Contribution Limits

Employer and employee contributions and forfeitures (nonvested employer contributions of terminated participants) are subject to a per-employee overall annual limitation. This limit is the lesser of:

All 401(k) plans may allow catch-up contributions of $6,000 in 2015 and 2016 for employees age 50 and over.

Vesting

Employee salary deferrals are immediately 100 percent vested -- that is, the money that an employee has contributed to the plan cannot be forfeited. When an employee leaves employment, he or she is entitled to those deferrals, plus any investment gains (or minus losses) on the deferrals.

In safe harbor 401(k) plans, all required employer contributions are always 100 percent vested. In traditional 401(k) plans, you can design your plan so that employer contributions become vested over time, according to a vesting schedule.

Nondiscrimination

To preserve the tax benefits of a 401(k) plan, the plan must provide substantive benefits for rank-and-file employees, not just business owners and managers. These requirements are called nondiscrimination rules and compare both plan participation and contributions of rank-and-file employees to those of owners/managers.

Traditional 401(k) plans are subject to annual testing to ensure that the amount of contributions made for rank-and-file employees is proportional to contributions made for owners and managers. In most cases, safe harbor 401(k) plans are not subject to annual nondiscrimination testing.

Investing 401(k) Plan Monies

After you decide on the type of 401(k) plan, you can consider the variety of investment options. One decision you will need to make in designing a plan is whether to permit your employees to direct the investment of their accounts or to manage the monies on their behalf. If you choose the former, you also need to decide what investment options to make available to the participants. Depending on the plan design you choose, you may want to hire someone either to determine the investment options to make available or to manage the plan's investments. Continually monitoring the investment options ensures that your selections remain in the best interests of your plan and its participants.

Fiduciary Responsibilities

Many of the actions needed to operate a 401(k) plan involve fiduciary decisions. This is true whether you hire someone to manage the plan for you or do some or all of the plan management yourself. Controlling the assets of the plan or using discretion in administering and managing the plan makes you or the entity you hire a plan fiduciary to the extent of that discretion or control. Hiring someone to perform fiduciary functions is itself a fiduciary act. Thus, fiduciary status is based on the functions performed for the plan, not a title.

Some decisions for a plan are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan, and to terminate a plan are business decisions. When making these decisions, you are acting on behalf of your business, not the plan, and therefore, you would not be a fiduciary. However, when you take steps to implement these decisions, you (or those you hire) are acting on behalf of the plan and thus, in making decisions, may be acting as fiduciaries.

Basic Responsibilities

Those persons or entities that are fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary's responsibilities include:

In addition, for some functions, there are specific rules that help guide the fiduciary. For example, the deductions from employees' paychecks for contribution to the plan must be deposited with the plan as soon as reasonably possible, but no later than the 15th business day of the month following the payday. If you can reasonably make the deposits in a shorter time frame, you need to make the deposits at that time.

For plans with fewer than 100 participants, salary reduction contributions deposited with the plan no later than the 7th business day following withholding by the employer will be considered contributed in compliance with the law.

For all contributions, employee and employer (if any), the plan must designate a fiduciary, typically the trustee, to make sure that contributions due to the plan are transmitted. If the plan and other documents are silent or ambiguous, the trustee generally has this responsibility. As part of following the plan documents in operating your plan, the plan document will need to be updated from time to time for changes in the law.

Limiting Liability

With these responsibilities, there is also some potential liability. However, there are actions you can take to demonstrate that you carried out your responsibilities properly as well as ways to limit your liability.

The fiduciary responsibilities cover the process used to carry out the plan functions rather than simply the end results. For example, if you or someone you hire makes the investment decisions for the plan, an investment does not have to be a "winner" if it was part of a prudent overall diversified investment portfolio for the plan. Since a fiduciary needs to carry out activities through a prudent process, you should document the decisionmaking process to demonstrate the rationale behind the decision at the time it was made.

In addition to the steps above, there are other ways to limit potential liability. The plan can be set up to give participants control of the investments in their accounts. For participants to have control, they must have sufficient information on the specifics of their investment options. If properly executed, this type of plan limits your liability for the investment decisions made by participants. You can also hire a service provider or providers to handle some or most of the fiduciary functions, setting up the agreement so that the person or entity then assumes liability.

Hiring a Service Provider

Even if you do hire a financial institution or retirement plan professional to manage the whole plan, you retain some fiduciary responsibility for the decision to select and keep that person or entity as the plan's service provider. Thus, you should document your selection process and monitor the services provided to determine if you need to make a change.

For a service contract or arrangement to be reasonable, service providers must provide certain information to you about the services they will provide to your plan and all of the compensation they will receive. This information will assist you in understanding the services, assessing the reasonableness of the compensation (direct and indirect), and determining any conflicts of interest that may impact the service provider's performance. Some additional items to consider in selecting a plan service provider:

Providing Information in Participant-Directed Plans

When plans allow participants to direct their investments, fiduciaries need to take steps to regularly make participants aware of their rights and responsibilities under the plan related to directing their investments. This includes providing plan and investment-related information, including information about fees and expenses that participants need to make informed decisions about the management of their individual accounts. Participants must receive the information before they can first direct their investment in the plan and annually thereafter. The investment-related information needs to be presented in a format, such as a chart, that allows for a comparison among the plan's investment options. A model chart is available on dol.gov/ebsa. If you use information provided by a service provider that you rely on reasonably and in good faith, you will be protected from liability for the completeness and accuracy of the information.

Prohibited Transactions and Exemptions

There are certain transactions that are prohibited under the law to prevent dealings with parties that have certain connections to the plan, self-dealing, or conflicts of interest that could harm the plan. However, there are a number of exceptions under the law, and additional exemptions may be granted by the U.S. Department of Labor, where protections for the plan are in place in conducting the transactions.

One exemption allows the provision of investment advice to participants who direct the investments in their accounts. This applies to the buying, selling, or holding of an investment related to the advice as well as to the receipt of related fees and other compensation by a fiduciary adviser. Please check dol.gov/ebsa for more information.

Another exemption in the law permits you to offer loans to participants through your plan. If you do, the loan program must be carried out in such a way that the plan and all other participants are protected. Thus, the decision on each loan request is treated as a plan investment and considered accordingly.

Bonding

Persons handling plan funds or other plan property generally must be covered by a fidelity bond to protect the plan against loss resulting from fraud and dishonesty by those covered by the bond.

Disclosing Plan Information to Participants

Plan disclosure documents keep participants informed about the basics of plan operation, alert them to changes in the plan's structure and operations, and provide them a chance to make decisions and take timely action about their accounts.

The summary plan description (SPD) -- the basic descriptive document -- is a plain-language explanation of the plan and must be comprehensive enough to apprise participants of their rights and responsibilities under the plan. It also informs participants about the plan features and what to expect of the plan.

Among other things, the SPD must include information about:

A summary of material modification (SMM) apprises participants of changes made to the plan or to the information required to be in the SPD. The SMM or an updated SPD must be automatically furnished to participants within a specified number of days after the change.

An individual benefit statement (IBS) shows the total plan benefits earned by a participant, vested benefits, the value of each investment in the account, information describing the ability to direct investments, and (for plans with participant direction) an explanation of the importance of a diversified portfolio. Plans that provide for participant-directed accounts must furnish quarterly individual benefit statements. Plans that do not provide for participant direction must furnish statements annually.

As noted above, for plans that allow participants to direct the investments in their accounts, plan and investment information, including information about fees and expenses, must be provided to participants before they can first direct investments and generally annually thereafter -- with information on the fees and expenses actually paid provided at least quarterly. The initial plan-related information may be distributed as part of the SPD provided when a participant joins the plan as long as it is provided before the participant can first direct investments. The information provided quarterly may be included with the IBS.

A summary annual report (SAR) is a narrative of the plan's annual return/report, the Form 5500, filed with the Federal Government (see Reporting to Government Agencies for more information). It must be furnished annually to participants.

A blackout period notice gives employees advance notice when a blackout period occurs, typically when plans change recordkeepers or investment options, or when plans add participants due to corporate mergers or acquisitions. During a blackout period, participants' rights to direct investments, take loans, or obtain distributions are suspended.

Reporting to Government Agencies

In addition to the disclosure documents that provide information to participants, plans must also report certain information to Government entities.

Form 5500 Annual Return/Report of Employee Benefit Plans

Plans are required to file an annual return/report with the Federal Government, in which information about the plan and its operation is disclosed to the IRS and the U.S. Department of Labor. Plans that must file the Form 5500 must do so electronically. These returns/reports are made available to the public.

Depending on the number and type of participants covered, most 401(k) plans must file one of the following forms:

Form 1099-R

Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. is used to report distributions (including rollovers) from a retirement plan. It is given to both the IRS and recipients of distributions from the plan during the year.

Form 8955-SSA

Form 8955-SSA, Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits, is used to report separated participants with deferred vested benefits. It is filed with the IRS. The information reported is generally given to the Social Security Administration who provides the reported information to the participants when they file for Social Security benefits.

Distributing Plan Benefits

The amount of benefits in a 401(k) plan is dependent on a participant's account balance at the time of distribution.

When participants are eligible to receive a distribution, 401(k) plans typically provide that participants can elect to:

TERMINATING A 401(k) PLAN

401(k) plans must be established with the intention of being continued indefinitely. However, business needs may require that employers terminate their 401(k) plans. For example, you may want to establish another type of retirement plan instead of the 401(k) plan.

Typically, the process of terminating a 401(k) plan includes amending the plan document, distributing all assets, and filing a final Form 5500. You must also notify your employees that the plan will be discontinued. Check with your plan's financial institution or a retirement plan professional to see what further action is necessary to terminate your 401(k) plan.

COMPLIANCE

Even with the best intentions, mistakes in plan operation can still happen. The U.S. Department of Labor and IRS have correction programs to help 401(k) plan sponsors correct plan errors, protect participants' interests, and keep the plan's tax benefits. These programs are structured to encourage early correction of the errors. Having an ongoing review program makes it easier to spot and correct mistakes in plan operations. See the Resources section for further information.

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The U.S. Department of Labor's (DOL's) Employee Benefits Security Administration and the IRS feature this booklet and additional information on retirement plans on their websites:

dol.gov/ebsa -- Go to the Saving Matters website at savingmatters.dol.gov or "Publications and Reports" for additional information to help you understand and operate your 401(k) plan. This website also has information to help your employees understand the importance of saving for retirement through an employer-sponsored plan.

irs.gov/retirement -- Go to "Plan Sponsor" to view plain-language information that will help you properly maintain your 401(k) plan. All the IRS forms and publications mentioned in this booklet are available here.

In addition, the following jointly developed publications are available on the DOL and IRS websites or can be ordered through the DOL toll-free number listed below:

Choosing a Retirement Solution for Your Small Business, Publication 3998, provides an overview of retirement plans available to small businesses.

Adding Automatic Enrollment to Your 401(k) Plan, Publication 4721, explains how to add automatic enrollment to your existing 401(k) plan.

Automatic Enrollment 401(k) Plans for Small Businesses, Publication 4674, explains a type of retirement plan that allows small businesses to increase plan participation.

Payroll Deduction IRAs for Small Businesses, Publication 4587, describes an arrangement that is an easy way for businesses to give employees an opportunity to save for retirement.

Profit Sharing Plans for Small Businesses, Publication 4806, describes a flexible way for businesses to help employees save for retirement.

SEP Retirement Plans for Small Businesses, Publication 4333, describes a low-cost retirement savings option for small businesses.

SIMPLE IRA Plans for Small Businesses, Publication 4334, describes a type of retirement plan designed especially for small businesses.

For business owners with a plan:

Retirement Plan Correction Programs, Publication 4224, provides a brief description of the IRS and DOL voluntary correction programs.

Order From:

DOL: Electronically at askebsa.dol.gov or by calling 866-444-3272

Related materials available from DOL:

For small businesses:

Understanding Retirement Plan Fees and Expenses

Meeting Your Fiduciary Responsibilities

Selecting an Auditor for Your Employee Benefit Plan

Reporting and Disclosure Guide for Employee Benefit Plans

Tips for Selecting and Monitoring Service Providers for Your Employee Benefit Plan.

In addition, DOL sponsors a website - the Small Business Advisor, available at /taxbasehttp://webapps.dol.gov/elaws/ebsaplan.htm - that encourages small business owners to choose the appropriate retirement plan for their businesses and provides resources on maintaining plans.

For employees:

A Look at 401(k) Plan Fees

What You Should Know about Your Retirement Plan (also in Spanish)

Savings Fitness . . . A Guide To Your Money and Your Financial Future (also in Spanish)

Taking the Mystery Out of Retirement Planning (also in Spanish)

Top 10 Ways to Prepare for Retirement (also in Spanish)

Women and Retirement Savings (also in Spanish)

To view these publications, go to dol.gov/ebsa and click on "Publications and Reports." To order publications or request assistance from a benefits advisor, contact EBSA electronically at askebsa.dol.gov or call toll free 866-444-3272.

Related materials available from the IRS:

The IRS Retirement Plan Products Guide, Publication 4460, lists resources to help you choose and maintain the right retirement plan for your business/organization.

Lots of Benefits, Publication 4118, discusses the benefits of sponsoring and participating in a retirement plan. (Also available in Spanish, Korean, Vietnamese, Chinese, and Russian.)

Have you had your Check-up this year? for Retirement Plans, Publication 3066, encourages employers to perform a periodic "check-up" of their retirement plans through the use of a checklist, and how to initiate any necessary corrective action.

401(k) Plan Checklist, Publication 4531, a tool to help you keep your plan in compliance with many of the important tax rules.

Designated Roth Accounts under 401(k), 403(b), or governmental 457(b) plans, Publication 4530, discusses this popular feature found in many 401(k), 403(b), and governmental 457(b) plans.

Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), Publication 560, describes types of plans, qualification rules, setting up a qualified plan, the minimum funding requirement, contributions, employer deduction, elective deferrals, the qualified Roth contribution program, distributions, prohibited transactions, and reporting requirements.

To view these related publications, go to irs.gov/retirement and click on "Forms & Publications" in the left pane.